AIG 2009 Annual Report Download - page 153

American International Group, Inc., and Subsidiaries
of such multi-sector CDO simultaneously with the exercise of its put option then, upon the expiration of ML III’s
aforementioned obligations with respect to such multi-sector CDO, AIGFP will be obligated under the related 2a-7
Put to purchase such multi-sector CDO at par in the circumstances and subject to the limited conditions provided for
in the relevant agreement.
Termination Events. Certain of the super senior credit default swaps provide the counterparties with an additional
termination right if AIG’s rating level falls to BBB or Baa2. At that level, counterparties to the CDS transactions with
the following net notional amounts, by portfolio, have the right to terminate the transactions early:
Net Notional Amount
(in millions) At December 31, 2009
Multi-sector CDO $ 1,517
Corporate arbitrage 8,537
Regulatory capital 298
Total $10,352
If counterparties exercise this right, the contracts provide for the counterparties to be compensated for the cost to
replace the transactions, or an amount reasonably determined in good faith to estimate the losses the counterparties
would incur as a result of the termination of the transactions.
Certain super senior credit default swaps written for regulatory capital relief, with a net notional amount of
$79.2 billion at December 31, 2009, include triggers that require certain actions to be taken by AIG once AIG’s rating
level falls to certain levels, which, if not taken, give rise to a right of the counterparties to terminate the CDS. Such
actions include posting collateral, transferring the swap or providing a guarantee from a more highly rated entity.
AIGFP has implemented collateral arrangements in a large majority of these transactions. In the event of a
termination of the contract that is caused by AIG’s rating downgrade, AIGFP is obligated to compensate the
counterparty based on its loss. As a result of AIGFP posting collateral, AIG eliminated the counterparties’ right to
terminate under this downgrade provision, thereby avoiding the uncertainty of determining the loss from an early
termination of a regulatory capital CDS.
Collateral
Most of AIGFP’s credit default swaps are subject to collateral posting provisions. These provisions differ among
counterparties and asset classes. Although AIGFP has collateral posting obligations associated with both regulatory
capital relief transactions and arbitrage transactions, the large majority of these obligations to date have been
associated with arbitrage transactions in respect of multi-sector CDOs.
The collateral arrangements in respect of the multi-sector CDO, regulatory capital and corporate arbitrage
transactions are nearly all documented under a Credit Support Annex (CSA) to an ISDA Master Agreement (Master
Agreement). The Master Agreement and CSA forms are standardized form agreements published by the ISDA, which
market participants have adopted as the primary contractual framework for various kinds of derivatives transactions,
including CDS. The Master Agreement and CSA forms are designed to be customized by counterparties to
accommodate their particular requirements for the anticipated types of swap transactions to be entered into. Elective
provisions and modifications of the standard terms are negotiated in connection with the execution of these
documents. The Master Agreement and CSA permit any provision contained in these documents to be further varied
or overridden by the individual transaction confirmations, providing flexibility to tailor provisions to accommodate the
requirements of any particular transaction. A CSA, if agreed by the parties to a Master Agreement, supplements and
forms part of the Master Agreement and contains provisions (among others) for the valuation of the covered
transactions, the delivery and release of collateral, the types of acceptable collateral, the grant of a security interest (in
the case of a CSA governed by New York law) or the outright transfer of title (in the case of a CSA governed by
English law) in the collateral that is posted, the calculation of the amount of collateral required, the valuation of the
collateral provided, the timing of any collateral demand or return, dispute mechanisms, and various other rights,
remedies and duties of the parties with respect to the collateral provided.
145 AIG 2009 Form 10-K